The U.S. Constitution had in 1787 explicitly called on Congress to establish “uniform Laws on the subject of Bankruptcies throughout the United States.” This would be good for the “regulation of commerce,” James Madison explained in Federalist Paper No. 42, “and will prevent so many frauds where the parties or their property may lie or be removed into different States.”
In April 1800, President John Adams signed the Bankruptcy Act into law. the 1800 law was nonetheless more forgiving than standard English practice. U.S. courts and creditors did not necessarily view insolvency as a moral failure. Sometimes businesspeople took risks that didn’t work out, and it was helpful to have a process to manage the unfortunate results, share the responsibility among creditors and debtors, and allow for fresh starts. But in 1803 Congress repealed the law.
Congress once again enacted bankruptcy laws in times of financial distress in 1841 and 1867, only to repeal them soon afterward. Bankruptcy remained an often-confused matter of state law and judicial interpretation until the passage of the Bankruptcy Act of 1898.
That’s not to say there haven’t been some big changes to U.S. bankruptcy law since 1898. During the financially distressed 1930s, Congress first added a provision allowing municipalities to declare bankruptcy, then rewrote the entire bankruptcy code. The latter reform made corporate bankruptcies less attractive by, among other things, requiring that an outside trustee be appointed to run the bankrupt company. Another major rewrite in 1978 took away that requirement, allowing the pre-bankruptcy management team to stay in charge.
Personal bankruptcy filings also rose after the 1978 reforms, and kept rising for decades. In response, Congress passed a law in 2005 that made it harder for individuals to get their consumer debts discharged. The result was a sharp decline in nonbusiness bankruptcy filings.
There’s always going to be a tension in bankruptcy between discouraging profligacy and enabling the insolvent to make a new start. It is a process of navigating deeply felt competing obligations. What is definitely a problem is the absence of any bankruptcy process at all.
In the U.S., one of the most controversial holes in the bankruptcy net is student debt, which, thanks to a series of ever-tighter restrictions adopted by Congress starting in 1976, is now so hard to get discharged that few try. The next change in bankruptcy law should deal with student debt obligations.